Not just about one firm

How a lesson in moral hazard sent the worlds markets for a ride...

a must read here

Re-Vote

After the bailout bill was turned down today in the house the markets plummeted. Nervousness is running wild on Wall Street. Hank Paulson just made a statement where he seems obviously frustrated and scared. This is not good news! Another bill can be brought to vote by the House Financial Services Committee headed by Barney Frank. However don't expect anything to happen in the next 2 days because of Rosh Hashanah. The problem with a re-vote is that people apparently opposed the bill today because they were ideologically against a bailout of hot shot Wall Street people. This leaves 2 options: A new bill with concessions from the Democrats or a dramatic change in constituents opinion on their connection to Wall Street. Either way we need to be quick and get something done now.

Ron Paul on the bailout

Here

The Next Big Bankruptcy...The Fed?

The Federal Reserve is giving a $85 billion dollar bridge loan to AIG and taking an 80% stake in the company. This news is flat out shocking considering they have been very active in so called "bailouts" but failed to do anything for Lehman Brothers. I thought America was based on capitalism. What happened to letting unprofitable businesses fail? I understand why some institutions need government backing because they play such an integral role to the economy and failure would just create more financial havoc. Fannie and Freddie are good examples of something that needs to be provided when the private sector fails to do so. But AIG? Do they have wide connections to the financial markets? To some extent they do because their businesses are so diverse from insurance to business financing. No doubt that something needed to happen with AIG but why do Americans have to pay for it. The Fed doesn't have $85B so they will have to borrow from the Treasury which means that more money will be injected in the economy. This is going to hurt the dollar and increase inflation, ultimately hurting consumers.

I will give the Fed credit though because they aren't resting on their laurels. Being counteractive is usually a good thing but when is enough, enough. They need to keep in mind all the debt they are accumulating. I hate to say it but this probably won't be the last takeover by the government. There are many other banks that are going to fail soon so we can only hope that the Fed will stay on the sidelines.

The bad part is that things are so bad that the Fed is considering crazy actions like this. There is no quick solution to the current crisis and we might not find a bottom until mid 2009. On the other hand, worldwide markets have responded well to the AIG news and we will probably see the same in the morning.

NYU Professor Predicts More Gloom

Click the title and it will take you to a 5 minute clip. Thanks to LPG for the link.

Lehman Update

Lehman is left with little options after talks to sell the firm have halted. There was said to be 3 potential suitors (Barclays, HSBC, and BofA) for the "good" part of Lehman. The "bad" part of Lehman which are poor performing loans and real estate assets were going to be absorbed by 10 large banks according to people familiar with the deal. Many of the firms are backing out of this because they don't think it's fair for them to take the bad stuff and for the other 3 to acquire the good stuff. That is a very fair point but they must realize the consequences of Lehman going under and the ramifications it will have on all the financials.

Bad news is that Barclays dropped it name from consideration and BofA is reported to be acquiring Merill Lynch. This leaves HSBC or the possibility of another bank like Goldman Sachs stepping up to the table. The prospects of a deal look don't look great anymore which put Lehman in a difficult situation. They will most likely have to declare bankruptcy and start reconciling their trades with other banks. It's going to take a miracle for Lehman to survive. Don't count the Fed out yet though because they have appeased every need on Wall Street throughout the entire crisis.

Making Money in a Down Market

The markets have been selling off recently and money has been sitting on the sidelines. It's going to start coming back into the market at some point in time, but many investors are extremely nervous right now. I think there is going to be more pain in the upcoming weeks, but money can still be made even in the financials. There are certain stocks that will do relatively better than others. Let's say you have two companies in a very similar businesses, but one is clearly better (clearly worse) than the other. A common strategy is to go long the stock you think will do relatively better and short the stock you think will do worse. This strategy allows you to make money in a down market/sector. For the financials, you could go long JP Morgan (JPM) and then short C (Citi) for example. JPM is seen as the most stable bank on the street while C is more tied to the general trend in financials. You can do this with a number of companies because the financial sector is so diverse. I would try to stay clear of names prominent in the news because those large percentage fluctuations could really damage your trade. Employing this strategy can make you money no matter the direction the market turns.

Lehman: The Week from Hell

Shares of Lehman have dropped over 75% in the last week! This is simply shocking and it leaves the market in a complete mess. Charlie Gasparino reported that Lehman is shopping itself to the street and 3 players have emerged lead by Bank of America along with Barclays and HSBC. I think LEH has gotten unfairly hit on their stock price. If it weren't for the wonderful precedent set forth by Bear Stearns, this stock would be trading at $7-8 easily. Now to be fair, they did lose $3.9B in the 3Q. Right now seems like a great chance for someone to get a great company at a discount. The asset management division is extremely valuable and the investment bank has done well in the past. The only problem is the balance sheet which is full of distressed mortgage related assets. Hopefully this won't discourage buyers. Many on the street were hoping that the Fed would guarantee a back drop for potential losses on Lehman as it did for Bear Stearns when JP Morgan acquired it, but no guarantee is on the table which has drawn out the takeover talks. If there was a back drop this would have already happened. They say that things will be done by Sunday and that people at the Treasury are in on the talks. The sooner this is figured out the better because this could be a disaster for the market.

Fed's Next Move

This is a really good article about the Fed and what the FOMC is going to do the next few meetings. After you read it one can help but be pessimistic about the economy. The jobless claims have been increasing, retail sales numbers were low this morning, unemployment is over 6%, and the list goes on. The real bad news is that the data is not going to get any better in the near future. Current strains on consumers is going to cripple consumer spending during a season when it is typically robust. All this is going to trickle down to lower GDP growth which is going to reinforce Wall Street's fears of a recession. I'm not going to start thinking recession until we get one quarter of negative growth, but it doesn't hurt to be prepared for it. The only good news we have seen in the markets is lowering commodity prices which should dampen inflation, and a strengthening U.S. dollar. It remains to be seen if the price moves will stabilize at these levels or maybe start trading in the opposite direction. If commodity prices start rising again we are in trouble because there will be greater inflation concerns combined with a weakening economy (stagflation). The run up in the dollar is going to hurt U.S. export industry, however a strong currency is good for economic growth making it cheaper to import good across borders.

What does this mean for the Fed? Well they won't do anything next Tuesday at the FOMC meeting, because they need to see more data before they make any major monetary policy changes. The language they use during the meeting will be huge and will give us a glimpse at how they are viewing the economy. I am really interested to see Dallas Fed president, Fisher's vote because he has been the lone inflation hawk of the FOMC and if he changes his opinion than sentiment has really changed. The next meeting is days before the presidential election so changing rates that day might not be politically popular (both candidates struggle with the economy). By then we will have a varied and balanced set of data for the Fed to evaluate. If current trends continue there will be pressure to cut rates to bolster economic growth.

Implicit Government Guarantee

From the Financial Ninja.

My Response to the Treasury Plan

The following is my response to the Government's take-over of FRE and FNM:

1. NEVER and I mean NEVER let Jim Lockhart speak. Ever.

2. Paulson made a very important point: The GSEs are NOT sustainable in their current form, and if we don't address the issue now, it will only come back to haunt us.

3. That being said, what is the Government doing buying WARRANTS of public companies? WARRANTS!?

4. The Government has permanently damaged these stocks. 80% ownership will have to be reduced at some point in the future, and knowing our government, the decision to sell the Government's stake will come to Congress and we will likely see heavy selling. Nice.

What are your thoughts?

The Treasury Shaking Up the Market

On Friday, the WSJ reported that the Treasury was in the works to takeover Fannie Mae (FNM) and Freddie Mac (FRE). The plan is expected to be detailed in 30 minutes at a press conference held by the Treasury. After the news was released on Friday, after market trading indicated a lower dollar because the takeover is going to increase the debt on the U.S. balance sheet. The shareholders are almost certainly going to be wiped out including both common and preferred which could inflict greater damage on the markets because many banks hold the preferred and if it gets cleared out they will be left with even less capital on their balance sheet.

It seems like the Fed and the Treasury have been doing a lot of work on Sunday's (Bear Stearns) which points to the seriousness of the issue. Many people have called for much more immediate action with Fannie and Freddie and this could also create some relief for the credit markets, but the details of the plan are critical because the 2 companies are said to hold $12T worth of mortgages which is over 50% of all mortgages in the nation. This is going to cost taxpayer dollars and right now with a budget deficit there is no wiggle room for inefficient policy. I think it's ironic that these companies that were created to help consumers through lower mortgage rates, but now in order to fix these GSEs taxpayers money is going to be used. Hopefully the new plan will allow the government to create liquidity in the mortgage market without creating a large tax burden on the American public.

More to come on this once the Treasury releases its plan!


UPDATE:

Plan Overview:http://online.wsj.com/article/SB122079276849707821.html?mod=hpp_us_whats_news

Official Statement:http://blogs.wsj.com/economics/2008/09/07/officials-statements-on-fannie-mae-and-freddie-mac/

Joy Global

This past week shares of JOYG has been off over 20% due to a worse than expected quarter and a broad free-fall in commodities. The move is shocking to many, but especially the CEO who expressed his displeasure on Mad Money. He acknowledged that the quarter was not as good as they wanted but Wall Street over reacted to the quarter. Backlogs at Joy Global have increased and sales were up 45%. The revenue numbers were great as well but many are concerned that the drop in commodity prices are making other fossil fuels like oil and natural gas much more attractive than coal. Coal is an extremely "dirty" energy source compared to oil and natural gas which also puts it at a disadvantage because we have seen a shift in worldwide sentiment on cleaner air and less carbon dioxide emissions.

Joy Global is not the only materials/commodity stock to take a hit this week. Freeport McMoran (FCX) and the oil service sector (OIH) were down 13% and 6% respectively this week. Commodity prices have increased greatly over the past years due to increased demand in the emerging markets especially China, but much of this demand is going and way and the companies are paying the price. This correction in markets was a little overdue because the growth rates in places like China and India were just too high to maintain. Lower commodity prices should help lower inflation pressures across the globe which is good for the Euro Zone which recently kept interest rates steady because of fears of inflation. Monetary policy at the ECB and the Fed will be more effective under conditions of tame inflation.

But can we assume that commodity prices will stay this low? Demand from the emerging markets will come back at some point which will certainly create a catalyst for these sectors. Now could be a great time to start researching these sectors for bargains, however be cautious because the next week shall prove very volatile because of what happened this week and the potential damage that Hurricane Ike may cause on the East Coast. Many are comparing it to Hurricane Andrew which caused about $25B in damage when it hit the coast in 1992. These sectors should offer some great trades in the coming weeks you just have to be patient and wait for the right entering point.

Use Your Head.

Below is a view of the documents from Sam Israel's Bayou Management's funds:


Please take a look at Bayou's email address.

IF THIS ISN'T A RED-FLAG, YOU SHOULD STICK TO MUTUAL FUNDS!!